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Quarterly Letter to Clients

April, 2016

Indices at quarter-end (March 31, 2016):

Dow Jones Industrials: 17,685.09 1Q'16 +1.49% YTD +1.49%

Standard & Poor's 500: 2,059.74 1Q'16 +0.77% YTD +0.77%

Here is the sort of stuff that occupies most of my waking hours:

Random thought #1: When the U.S. dollar is strong, as it was for the last couple of years, the earnings of U. S.-based international companies are hurt by the translation from weaker currencies back into the dollar. This year we saw the strength of the dollar start to ebb, and we can thus expect that American companies doing business abroad will have a prettier picture to paint during earnings season.

Random thought #2: Just when it seemed interest rates couldn't get any lower comes the advent of negative interest rates in some parts of the world. Given that American companies are holding cash in the area of $1.5 trillion abroad (to avoid being taxed upon repatriation of the money), one has to ponder the net effect of negative interest rates versus a weakening dollar.

Random thought #3: We have been experiencing a movement of American companies to change their domicile to foreign nations that offer a more benign tax structure. Does anyone believe that if we lower corporate taxes that our competitors will not further lower theirs? This is a political football, but no matter your opinion, the fact remains that when our companies finagle lower taxes, it is you and I that are left to pick up the slack.

And an observation: Contrary to what everyone thought would happen, oil is up and interest rates aren't.

These are larger-picture issues, only incidentally connected, and of interest simply because all of the pieces of the machine work together. No single factor alone can be blamed for the volatility of our stock markets of late.

The most recent stock market top, and an all-time high, was hit in March of 2015, so we have been in a gradual downtrend for a year now. That movement was punctuated by several very sharp falls, which were then mostly offset by equally sharp rises. Look at the period just ended: it was a wrenching quarter, starting with a drop of almost 13% from early January to mid-February. That was followed by a rebound of more than 2000 Dow points, to finally finish the quarter with a small gain in the averages.

Several times in the recent past I have written about the number of consecutive up years in the markets. Now it seems appropriate to write about declining markets.

Over the 62-year span from 1953 to 2015, the market (measured by the Dow Jones) showed positive results in 49 years. Of the 13 years that experienced declines, 10 were of only one year's duration, two lasted 2 years, and only one, the period from 2000-2002, extended three years.

There are many ways to parse this information. For example, you could say that the market goes up almost 4 times as often as it goes down. Or that anytime we have a down market, the next year will probably be up. Or you could say that it is highly likely that the market will not go down for more than two consecutive years. All true.

But this masks reality: we have experienced in our history long periods of sideways moves, lasting anywhere from eight years to eighteen years. So even though you may not have had more than one or two down years in a row, you still did not make any money for a very long time.

On the other hand, as we optimists will note, we have also seen equally long periods of rising markets, verifying the adage that you have to be in it to win it.

None of this discussion will make it any easier when we open our monthly statements, though. Basically, we have to live through the downs just like we live through the ups. If you have cash to invest, you should be pleased when the market is down, as you will be able to buy at lower prices. If you are fully invested, you can take comfort that in our entire history the long-term trend has been up, and you just have to wait it out. Time is our best friend, at least until we run out of it.

The strategy that I find most appropriate is to structure your financial house to withstand whatever squalls may arise. We must balance risk to the point at which we are not sickened when markets tumble. This becomes more important as we advance in age and find stability to be of more importance than "winning." We learn that in difficult times stability is often the winning strategy anyway. The tortoise and the hare is an ancient story that is still relevant today.

Jim Pappas